Sleepwalking to pensioner poverty

Appetite for change in the at-retirement process is gaining momentum. Not before time, finds John Lappin

With the at-retirement market set to top £23bn by 2013, according to a Towers Watson report, defined contribution funds are getting ever larger.

But while the way in which DC pots are being accumulated is becoming increasingly sophisticated, the science of converting funds into income remains flawed.

It is still the case that thousands of retirees each year sleepwalk into unsuitable products, because they have not properly considered inflation protection, spouses’ benefits, enhanced annuities or even maintaining exposure to stock markets.

But while the annuitisation process has been like an open wound for the life insurance market for years, the lobby in favour of extensive reform of the Open Market Option and its conversion into a ’pension passport’ system is steadily gaining momentum.

The Pension Income Choice Association (Pica) proposal is that a new type of ’pension passport’ should be issued to retirees from their incumbent provider. This would outline the relevant personal and financial data about an individual and would ask them their preferential financial retirement option, such as which type of annuity they prefer. It would also have a section about past or present medical conditions, to allow enhanced rates to be easily calculated. Once the passport has been completed, the annuitant would then be able to more easily shop between providers, armed with a broad outline of their financial position, their preferential option and a brief medical history, says Pica.

Much of the running has been made by a group of intermediaries, fund managers and a new generation of providers of enhanced and asset-backed annuities in Pica.

To date, much of the heat in the debate has been between Pica and the Association of British Insurers, but what part do corporate advisers play?

One of the things we haven’t seen yet is a high profile case of a member not exercising the open market option suing a trustee, if that does happen that would open the flood gates

Certainly the industry is regarded by some as an impediment to change.

Origen head of retirement strategy Rob Tinsley says: “We would say there is not enough being done. The statistics back that up in terms of the number taking the open market option and certainly the rather low number of people who are benefiting from the impaired enhanced rates. It is a combination of information and lack of advice generally in the corporate environment. People connect at the employer level not employee level because it is difficult to deal with in a cost effective manner.”

All agree that a situation where a pension saver simply takes the default annuity option, particularly where the provider concerned does not offer an especially good rate, is far from the optimal outcome. But opinion is divided on the detail of what to do.

Some believe there is lot that can be done before getting to the point of giving advice.

Steve Herbert, head of benefits strategy at Jelf, says: “There is a long way to go before you get anywhere near the advice bit. One of the duties which falls fairly on the advisers and EBCs is that right from the very first presentation introducing the scheme, they should be talking about the options at the other end. That should also be flagged up repeatedly in the four or five years coming up to the retirement age. There is quite a lot that can be done in terms of educating employees.

“The problem with DC is the employees can’t quite get their heads round the concept that you buy a savings vehicle and then you buy a pension.”

Origen espouses a similar approach. Tinsley says they are contacting employees five years out from retirement about their plans. He says this provides a wealth of information – if a member wants to retire fully or to carry on working and whether any employees are close to fully funded. It also allows conversations about lifestyling options and could prompt the consolidation of several pots of money.

“You have hopefully done two things, you get people thinking about their retirement and from our perspective hopefully they build a relationship up with us. It is something that a lot of employers can do fairly easily,” he says.

However with smaller pots the actual retirement decision is more of a challenge.

Behavioural economics will only get you so far. At some point you have to engage with people, and this is particularly important where there isn’t any one default

Tinsley says: “It is a challenge for us to make it an efficient way for dealing with the advice piece. We can do it effectively to £30,000 but then you start sounding expensive to people. We have got to look at better use of technology in that space.”

Could the passport soon open things up? Pica chairman Tom McPhail believes real change could be just around the corner. He says: “We have had lots of conversations going on at ministerial level and with organisations such as the Pensions Regulator and Nest. I am comfortable there is a reasonably strong consensus developing that the open market option is not fit for purpose. We need to look at how we present the choices to investors to make sure they engage with the decisions they need to make. We have significantly moved the ABI forward in terms of how they are thinking about this issue too.”

McPhail, who is also head of pensions research at Hargreaves Lansdown, believes that other government initiatives such as trivial commutation will help simplify the process too. But he believes that the much-in-vogue behavioural economics solutions have limits when applied to decisions about taking pension income.

“There is recognition that behavioural economics – the use of defaults – can deliver desirable outcomes with limited input. Auto-enrolment is one example. The interesting question is what you do to complete the picture. Behavioural economics will only get you so far. At some point you have to engage with people and this is particularly important where there isn’t any one default.”

“You have to make some decisions if only about single or joint life or level or escalating. Otherwise you get outcomes that are below what would be desirable.”

Others believe the answer lies in employers bringing in specialist annuity services and that may be happening already.
Better Retirement director William Burrows says that increasingly trustees are bringing in specialist annuity help, but he is concerned about contract-based pensions.

“With a contract-based pension it may be less of an issue if the contract is with say Aviva, but with a company that has poor rates it is really important to appoint an adviser to shop around on the open market.”

Burrows says that a court challenge by a disgruntled annuitant who had taken a poor default option would be a huge catalyst for change in the corporate sector.

“One of the things we haven’t seen yet is a high profile case of a member not exercising the open market option suing a trustee, if that does happen that would open the flood gates.”

Steve Lowe, a director with Just Retirement and another Pica member, sees OMO reform as key but he also believes technology will help trustees overcome their fears about encroaching into the advice space.

At the moment I am not seeing much coming out of RDR which is designed specifically to satisfy the needs of the 80 per cent of the population that won’t be paying for regulated independent advice

He says that Just Retirement subsidiary The Open Market Annuity Service is extending its reach beyond annuities to other products in 2011. He says: “That will give employers or trustees the ability to plug in a platform that reduces their perceived regulatory risk. It gives them a chance to give their members a real opportunity to shop around the market. Those services are starting to emerge more.”

Not all are as convinced as Lowe that anything other than annuities can be offered easily through such a system though they see it as increasingly likely to happen.

Burrows would like to see those who decided on an asset-backed solution to be moved across from the information sphere into an advised one.
McPhail accepts that Hargreaves Lansdown’s offering to FTSE 100 firms does not go beyond annuities at the moment and says finding a way to offer an asset-backed product may be a bit of a holy grail.

Herbert says: “I certainly think we will get there, but whether we should is another question. I think it is going to come because of Nest though I think we are a way away yet. But I equally think there could be a disaster around it.”

Does the solution rest with a simplified form of advice?

McPhail would like to see some movement from regulators around the RDR.

“At the moment, I am not seeing much coming out of RDR which is designed specifically to satisfy the needs of the 80 per cent of the population that won’t be paying for regulated independent advice. HL’s business model works well on giving people good quality information but we are quite an exception in that regard – the more the regulator can come up with generalised guidance the better. Maybe a degree of limited advice light, but I’m not being prescriptive about what the answer is there.”

Hargreaves is one of a handful of firms offering an annuity supermarket to DC schemes, using the commission from providers to pay for the service. So how will the RDR change that business model?

“The easy way around it is to say ’we charge a 1 per cent or whatever fee for broking’. There will be competitive pressure in the individual market, where intermediaries will say they can do it for less, but in the workplace, employees are likely to want to use what they are offered.”

Tinsley says that certainly for smaller pots it will get more difficult under RDR to provide full advice.

“You can look at ways of helping people, without doing the full whole of market advice. You can make sure they are better off and make sure they choose the right shapes, but it is not an easy thing.”

Richard Jacobs, owner of Richard Jacobs Pension and Trustee Services is convinced that under RDR, ways to pay for full advice will and must emerge.

“With drawdown and flexible drawdown and the new types of annuities and temporary annuities, the choices are wider than ever. That needs advice – specialised advice. You can’t advise on retirement without understanding drawdown. Drawdown is a fantastic contract but boy there are a lot of risk involved. We are talking about needing highly qualified people and it is not something for the banks or restricted advice area. I actually am carrying on investing in this area but I am working on the basis that some solution will be found.”

However he also believes that all the talk about improving the OMO could risk seeing the “same old provider cartel” getting together. He thinks that means misselling and is wary of the passport too, though he sees merit in it.

“The trouble is it plays to the providers’ position. It is typical that we allow providers to dictate to us. The person has got to tick a box but then people will think because they have gone down that route, they have got the best deal. You have got to discuss drawdown and family circumstances. You’d be amazed for example how many people moving into retirement are considering divorce.”

While Jacobs isn’t sure what models will emerge to pay for advice, Herbert thinks in the workplace it will fit with consultancy charging.
Herbert says: “Ultimately the advice piece will be wrapped up with the consultancy charge, along with other charges. I suspect that once employers understand the importance of it, it will be part of the core costs of running a scheme.”

Such a bundling of charges could be potentially unpalatable, warns McPhail, particularly with the likes of Danish entrant ATP, US fund manager Vanguard and UK City veteran Terry Smith spreading the argument that prices should be low and clearly explained.

McPhail says: “Certainly, you need to keep down costs, but you have to pay for engagement and if you do engagement well, then people start thinking about their savings and their money as well. They save more and save more intelligently. Ultimately you get better outcomes, but that needs to be paid for.